Good news for the economy, bad news for markets?

Key takeaways

US inflation appears to be headed in the right direction, and economic growth in the UK has been stronger-than-expected. However, investors took this as a sign of higher interest rates to come, and reacted accordingly…

• US inflation (measured by the Consumer Price Index, or CPI) rose slightly in July, though the pace of price increases still appears to be slowing. Inflation increased by 0.2% when compared with June this year, and by 3.2% when compared with July 2022. As a reminder, US inflation reached a peak of 9.1% in June 2022. While this is still some way off the US central bank’s target of 2%, inflation does appear to be broadly headed in the right direction, with changes in airline fares, used car prices and rents all helping pricing pressures to ease back.
  
  
• Despite this apparently benign news on US inflation, US bond yields rose a little last week, as policymakers at the US central bank implied that there was more work to be done. In practical terms, this suggests further interest rate hikes from the US central bank. Bond yields (which move in the opposite direction to bond prices) are ultimately priced according to the benchmark rates set by central banks, but they also reflect market expectations for future interest rate levels. Bond yields (and therefore bond prices) can move very quickly as a result of changes in investor expectations. This was the case last week, hence the rises in bond yields (and falls in bond prices).
  
  
• In the UK, the latest figures showed that the economy grew by 0.2% in the second quarter of the year (April-June). This was partly driven by good consumer activity. In a perverse case of good economic news being received as bad market news, this better-than-expected result led investors to believe that this would give the Bank of England more space to keep hiking rates in order to tackle inflation. As a result, similarly to the US market, UK bond yields rose (and their prices fell).
  
  
• Generally, bond prices and share prices are expected to move in opposite directions, especially during periods of macroeconomic uncertainty. Roughly speaking, stock markets typically sell off when investors are worried about the outlook for the economy, leading them to switch to traditionally safer assets like bonds. However, both stock and bond markets performed relatively poorly last week, as the inflation and interest rate concerns which had impacted bond markets also created concerns about the outlook for the economy, and the knock-on effects for company profits. This caused some weakness in share prices too.

Weekly market moves

• Both bond and stock markets fell last week, as investors responded to inflation news by expecting even higher interest rates.

• The oil price fell slightly, giving back some of the gains it had made in the previous week.

What to look out for this week

• Economic data due for release this week includes UK inflation figures and employment market data for July, as well as updates on US retail sales and industrial production.